1.1- How economists think about choices

Choices economists have to make

• How do societies choose to allocate scarce resources among different alternatives?

• Understand how each member of a society, such as individuals and firms, makes economic choices.

Assumption of behaviour in economic analysis

• Economic analysis- assumption individuals behave rationally when making choices.

• Assumption of rationality- cornerstone in economic analysis- can be used to explain several aspects of the economic behaviour of individuals.

Rationality

• Individuals use all the relevant information to make choices in their best interest and those choices are based on reason and not affected by emotional or unconscious factors.

• Rational individuals use all the relevant information to compare benefits and costs (including opportunity costs) associated with those decisions. A choice is made only if the benefit of doing it is larger than its cost.

How does rationality answer questions

• Idea of a rational choice provides an answer to the questions what to produce, how to produce, for whom to produce and also how much is produced:

• We should produce something for which the benefits of producing it are larger than the costs of producing it.

• We should produce goods in the least costly way and for the individuals who value those goods most

Monetary benefits

• Benefits of a given activity- what we gain from doing it- often measured in monetary terms- amount of money we get from a given activity.

• Other cases less straightforward.

• Even when benefits cannot be readily available in monetary terms we can still try to provide a monetary value for them.

• Benefits of a given action- the willingness to pay for that action.

• The willingness to pay for something- the maximum amount of money we are willing to pay for it- hypothetical monetary value- normally don’t pay that money.

• Different individuals can have different willingness to pay for the same thing.